Don’t Use Your TFSA as a Savings Account

According to a recent post by Garth Turner, the gift, only 4 in 10 Canadians have a TFSA (Tax Free Savings Account). Of those only half actually do anything with it. In addition 80% of people with a TFSA have it sitting in high interest savings accounts. Garth writes:

“Despite being able to shelter all this money from any kind of tax, most don’t. Only four in ten people have a TFSA, even five years after it was created. Of those only half actually contribute to them. And (are you sitting?) eighty per cent of people with a tax-free savings accounts have the money in savings. Yup. High-interest savings accounts paying 1.5% or maybe two.”

Currently, Canadians are allowed to contribute a maximum of $25,500 to their TFSA. That’s $5,000 per year from 2009 to 2012, and $5,500 for 2013. However for all the benefits of the TFSA, the majority of Canadians are not contributing. That’s a shame, because the TFSA makes an excellent retirement investment account, and the best tax-sheltered deal around!

There’s More Than Just Savings

When the Federal Government introduced the TFSA (Tax Free Savings Account) back in the 2008 federal budget, most Canadians were simply uninterested in another government regulated savings account. Therein was the problem in the first place, because the name “Savings” was completely misleading. Many Canadians assumed and still do, that the only thing they can do with a TFSA is hold cash or a GIC at a paltry savings rate. They are certainly not getting the full benefit of compound growth with rates at 1.5%.

In fact, you can open a TFSA with your discount brokerage, such as Questrade or with your bank, and start trading any number of securities.** This includes stocks, bonds, mutual funds, or ETFs. 😉

The TFSA gives you investment options beyond simple low-rate savings. If you need short term savings then use a savings account. With all time low interest rates, you won’t be keeping pace with inflation, and the amount of taxable interest would be minimal. Nor would you be taking advantage of tax-free compound growth in your TFSA with a low interest rate.

The Golden Nest Egg

The real power of the TFSA is to use it as a retirement investment account. There are four main reasons:

Tax free compound growth.

Tax free withdrawals.

No age restriction.

No impact on government benefits.

Tax Free Growth and Withdrawals

First, all income can grow tax-free sheltered in the TFSA. That can include interest, bond payments, dividends, and capital gains, as long as it’s not foreign income. Second, you can withdraw any amount from your TFSA tax-free. That’s right, not only can you partake in tax free growth, you can also withdraw money from your TFSA at anytime you want. You can even contribute back your withdrawals in future years.

No Age Restriction

Third, there is no age restriction with the TFSA, unlike turning 71 with a RRSP. You can keep the TFSA until your 91 if you want to, and withdraw any amount you want tax-free. This is much different than converting your RRSP into a RRIF, where you have to withdraw a certain percentage, and then pay tax on those withdrawals. No need to deal with insurance companies and annuities either, unless you want to. That makes the TFSA simple and easy to understand.

No Impact on Government Benefits

Fourth, the TFSA golden egg comes from the tax-free withdrawals. While you don’t get a refund each year as with the RRSP, you do get a much better benefit in retirement. Since you didn’t get an immediate tax deduction when contributing to your TFSA, the government does not consider TFSA withdrawals as income.

This means, that any money withdrawn from your TFSA will not affect government benefits, OAS claw backs, or GIS (guaranteed income supplement). Here is what the official TFSA Pamphlet from the Government of Canada states:

“Your TFSA withdrawals and growth within your account are not included in your income—they are tax-free… Neither income earned in a TFSA nor withdrawals from a TFSA will affect your eligibility for federal income-tested benefits and credits, such as the Guaranteed Income Supplement and the Canada Child Tax Benefit.”

Having an extra income stream in retirement is a big plus. With the TFSA you won’t have to worry about taxable withdrawals or impacting government benefits. Let’s hope the government keeps it that way. 😉

Conclusion

The Government’s own TFSA Pamphlet, as well as the majority of banks promote the TFSA as nothing more than a savings account. Yet, the TFSA gives you a powerful investing account. In addition it gives you a powerful financial tool to generate tax-free income during retirement, without age restriction, nor an impact on government benefits. The TFSA truly is a golden nest-egg for retirement. If you are only using your TFSA as a short-term savings account, then think twice. 😉

Readers, what’s your take? Do you utilize the TFSA for your retirement strategy?

Notes:

** The only things you can’t hold tax-free in your TFSA are foreign securities – such as U.S. dividend stocks. So if you do use your TFSA for dividend stocks, keep it Canadian. Hold U.S. stocks inside your RRSP, since U.S. dividends will be tax exempt in the RRSP. In addition, you cannot claim back the federal foreign tax credit for foreign securities inside the TFSA.

55 Responses to “Don’t Use Your TFSA as a Savings Account”

Leslie, a number of companies are dual-listed. That means their shares trade on both U.S. and Canadian exchanges. Some even trade under the same symbol. i.e. The Royal Bank of Canada trades as RY on both exchnages. On the TSX as RY-T, and on the NYSE as RY-N. But I’m not aware of any U.S. listed stocks that trade on the TSX. Can you clarify?

But if the stock does not trade on a Canadian exchnage, then it would be a foreign stock.

I’m sorry, but I don’t know the correct terminology. I was thinking of a dual-listed security (NYSE and TSX) that I have in my TFSA. The relevant entity is based in the USA. That’s OK, I gather from what you’ve said.

Unfortunately, it is marketed as a savings account and not as a retirement vehicle. I know many people who do this and who probably won’t change, although I think many of us do realize the actual benefits we could see 20, 30 or 40 years down the road. But for many people, this makes RRSPs still a better means of savings – because people are far less likely to withdraw because of the tax consequences.

Because the overall limit ($25,500) is still low compared to most people’s RRSP contribution room, it’s viewed as a short-term savings vehicle for a car, house purchase or vacation in 1 or 2 years. Due to recent market volatility and because of their short-term need, people opt for the safety in a savings account instead of the growth in an equity portfolio.

Brian that’s a good point, and it certainly can be used for a savings account, for those kinds of purchases. I think that’s a pretty good idea actually. But with savings rates at only 1% to 1.5% the tax you would pay on interest is pretty minimal.

I just think there is a lot more bang for the buck using it as part of an overall retirment plan. Obviously it really depends on your needs, short term vs. long term.

Yes unbalanced, that is completely correct. As Brian points out, you can withdraw money from your TFSA, and add it back in any time in the future. The withdrawals are added onto your contribution room. Just remember not to add the withdrawals back in the same year. 😉

“You can withdraw funds available in your TFSA at any time for any purpose — and the full amount of withdrawals can be put back into your TFSA in future years… Gillian decides to re-contribute the $40,000 to her TFSA (the amount she withdrew). She may do so without reducing her other available contribution room.”

Just to throw a wrench in the works Farcodev, you should at some point consider U.S. stocks in the RRSP, once you have the TFSA maxed out.

American companies are some of the biggest in the world, and offer diversification way beyond our Canadian economy, especially in the consumer staples.The TSX is primarily financials, resources, utilities,and 3 telecom giants. Just sayin. 😉

We are using our TFSAs to invest in dividend paying stocks. If we need the money before retirement, we’ll use it. Otherwise it will end up for retirement. When the TFSA first started and it was only $5000 I kept it as cash in a savings account TFSA. But by the second year, I could have $10,000 in a TFSA, so I withdrew the 5000 plus interest on Dec 31st and deposited in a new brokerage acct on Jan 1. I will encourage all the younger people in my life to start a TFSA as soon as they are 18 if they can find any money to save.

Oh dear… I am one of the guilty ones in a high interest savings account… does anyone know if I can do a direct transfer from my TFSA account into my brokerage account (with a different institution) or maybe I would be better off waiting until next Dec 31 and doing what Bet Crooks suggested… withdrawal on Dec 31 and redeposit on Jan 1?

Hi Amy, yes you can just transfer your TFSA to another institution without having to do a withdrawal. Most banks have a brokerage account though, so you could just keep it with your own bank and have them move it for you, without incurring a withdrawal. 😉

Every Canadian discount brokerage through a bank, does not have fees for the TFSA, other than the standard trading fee, as far as I am aware.

Just a note of caution on transfer fees. When I tried to transfer my TFSA from Questrade to TD eseries, Questrade said they would charge $125 for the transfer. Luckily, two weeks later they announced that they would no longer charge any fees for buying ETFs. As a passive index investor, that’s all I needed to hear. I’ll stay with Questrade and save the $125.

Conventional wisdom is, as you say, “Hold U.S. stocks inside your RRSP, since U.S. dividends will be tax exempt in the RRSP. In addition, you cannot claim back the federal foreign tax credit for foreign securities inside the TFSA.”

Option A: hold the US dividends in a non-registered, and pay-as-you go at marginal tax rates/capital gains rate.

Option B: hold the US dividends in an RRSP, and pay all gains at marginal tax rates upon withdrawal.

Option C: hold the US dividends in a TFSA and pay only the 15% US witholding fee.

It’s an intersting point isn’t it, because you will end up paying the tax now or later.

Option C: This is the worst case possible scenario in the TFSA. You will be fully taxed on the dividend income and unable to claim the federal foreign tax credit.

Option B: In the RRSP you will get tax-free compound growth without paying any tax on the income, and shelter any captial gains. Of course you will pay FULL tax on whatever you withdraw lqter from your RRSP.

Option A: Although the dividend income is initially taxable you should be able to claim the federal foregin tax credit against the witholding taxes.

Okay, I was unaware of the “foreign income” stipulation of the TFSA before reading this. If I am using foreign stocks for growth (ie – non-dividend paying US stocks) and buying and selling regularly, are these capital gains taxable inside the TFSA?

OK, I’m missing something. “in the TFSA. You will be fully taxed” – TFSA is “tax-free”, is it not – with the sole exception of the 15% the US taxman takes – still better than marginal rate outside of a TFSA, isn’t it?

It’s tax free because you are investing with $ that you have already declared as income and paid tax on; the tax-free portion really just applies on the capital growth and income that is derived from the $ in the TFSA.

Up to this year what I have contributed has been in a “high” interest TFSA. This year I opened up an account with TD Waterhouse where 66% of my savings are in TD e series (25% Cdn Bonds, Cdn Equity, Dow-Jones, International each…I’m 33).
Since you can’t hold US stocks I figured this is the best way to diversify.
I like this option because I may need to dip into these funds to take on a new mortgage within the next year or two (first mortgage on reasonable home paid off). Having no fees for buying or selling the e series plus their low MER rates makes this doable I think.
In future I plan to take positions on reliable high yield Cdn dividend stocks in my TFSA. I currently have a few US high yield positions and an above average performing mutual fund in my RRSP.
I’d like to know if this seems reasonable.

Hi, good work on getting started early and on the right track! You will save a fortune on fees with the TD eSeries funds, and that will definitely pay off in the long term…

Keeping eSeries Canadian Bond Index and Canadian Equity Index in the TFSA is perfect, because you will keep the interest income and Canadian dividend income sheltered.

However, the Dow-Jones Index and International Index funds need to be in a non-registered account. Although they are Canadian Funds, they are “Canadian domiciled funds” holding foreign equities. There will be foreign withholding taxes taken off at the source. You will not be able to claim back the federal foreign tax credit if the funds are in a TFSA or RRSP, and you will be dinged them anyway.

Wouldn’t paying down debt be a safer bet than a TFSA? It would have a higher rate of return than a high-interest account, and less volatility than stocks.

Also, contributing to an RRSP should be the main priority, since you will be taxed at a (usually) lower rate when you take it out at retirement. And I think this explains why so few people use the TFSA — they don’t have enough money to even max out their RRSPs.

Yes if you have consumer debt, no question, you should work on paying down your debt first! But that’s an entirely different post. 😉

I have no problem with the RRSP, and many readers here do both, max out their TFSA and then contribute to their RRSP. I contribute to both as well.

Lower tax bracket or not in retirement, you will still end up paying tax on the withdrawals! That’s not just your original contribution, but on all the years of compounding growth as well. You actually end up paying more for the refund now. 😉

I’m looking at it the opposite way you are – that is max out the TFSA (since its only 5.5K) then contribute to the RRSP. I know very few people who can actually max out their RRSP.

If you can’t contribute more than 5K in either plan, and you don’t owe additional taxes, then choose the TFSA over the RRSP, so you don’t pay tax on it later. My opinion.

This might be a silly question to you pros out there but I am not as familiar with the rules with TFSAs. My wife and I both have TFSAs from our respective banks. Both have dividend paying stocks. We both went to her bank last week to add to her TFSA. Since she already had $20000 in it, we naturally wanted to add in an extra 5500. The TSA had grown to 20500 or something. However, the teller at said bank (TD) told us that she should only put in 5000 and not the 5500 since the total, if we had put in the 5500, would be penalized. I wasn’t sure so we decided to play it safe until I did more research. Was the teller correct or is my wife still able to place the full 5500, regardless of how much the TFSA has grown by?

Thanks for clearing this up for me. I still need to add to mine as well.

The bank teller was incorrect. Your total contribution room is $25,500 per TFSA. That’s $5,000 per year from 2009 to 2012, and $5,500 for 2013. The value of the TFSA is irrlevant, it is how much you have initially contributed each year.

For example some investors have 40K or 50K in their TFSA because they have taken on higher risk investments. They could still add 5.5K for 2013 if they haven’t contributed yet for 2013.

In addition you could have withdrawn $7K from your TFSA last year, and your contribution room would be $12.5K for this year. You are allowed to recontribute your withdrawals, as long as it’s not recontributed in the same year.

I have maxed out my and my wife’s TFSA each year, hers with the highest rate GIC’s I could find, mine with mutual funds (recommended by a popular Canadian author) and stocks. Her’s is now worth about $27K, mine is at approx. $23K. I don’t think GIC’s are such a bad idea, at least they go up.

Unfortunately, you are one of many Canadian investors who purchase actively managed mutual funds, and who are paying a premium in fees and being rewarded with under-performance.

Since markets have done pretty-well over the last year, and especially over the last 6 months your funds should not be lagging. You may also want to review what funds you are holding, and if that matches your asset allocation. Did you take on higher volatility equity or sector funds? Or better yet go the Index Fund and Index ETF route:

I got a trick question for all of you. I got some rds.a (shell stock) on the euronext in amterdam. What should I do?

A. Hold it TFSA and get hit the witholding tax but cash in the difference in tax vs unregistred
B. Hold it in a RRSP it will be same as TFSA, because am not been able to know if canada got an agrement with netherland for witholding tax
C. Hold it in unregister account, claim a tax credit but get hit on tax on the 5% dividend.

My bet is A but if someone know about witholding tax for netherland I will chose B to get the best of both world.

The answer to your question is to keep it in a non-registered account. This way you will be able to claim the taxes paid on the foreign dividend income, back under the FTC (Foreign Tax Credit). You will be charged the foreign-tax anyway in a registered account (TFSA and RRSP) and will not be able to claim the taxes back. You will lose the benefit of the FTC under registered accounts. Therefore, non-registered account is best. However it would be subject to Capital Gains tax (or loss) if sold in a non-registered account.

Brian So will be covering the FTC (foreign tax credit) for foreign securities in his next post. You can wait until then for the definitive answer. For a quick idea you might want to check out his other post on U.S. securities (in your case its foreign income – so no tax-treaty):

But in an unregistred the tax man will take away 38% of the 5% dividend (I am in the highest tax bracket in Alberta) of my dividend so from my point of view am suppose to receive (5%-5%*0.38) = 3.1%+ pay any capital gain when I want to sell and the trouble to get my tax credit.

In a TFSA I will pay 15% of witholding tax on the dividend (5%-5%*0.15)= 4.25% + don’t have to pay capital gain on the apreciation when I sell.

So my question why you advise me to take 3.1% dividend in a unregistred vs 4.25% dividend in a TFSA try to enlighten me with your ninja skill.

Francis, I assume you are specifically referring to U.S. stocks. The RRSP would be the best place for these, since everything inlcuding the U.S. dividend income and capital gains is tax-free. The TFSA is the worst possible place for U.S. stocks becuase you will lose the foreign tax credit, and it will not be recoverable. Albeit, the capital gains being tax-free. See this recent post by advisor Brian So, where he specifically discusses in which account to place U.S. stocks:

Yes you will want to hold foreign stocks in a non-registered account, so you can claim back the federal foreign tax credit, or your RRSP. Your foreign taxes withheld could possibly be more than 15% (which applies to U.S. stocks). That’s just not my expertise.

Whatever the amount of taxation is, it will not be recoverable in the TFSA.

Yes you are correct, the capital gains are not taxable in a registered account, even for a foreign stock.

It really comes down to whether you want to sell (shelter capital gains) or hold (collect dividend income) the stock.

Really !? A TFSA is not tax free on foreign dividen that the bigest rip off I ever heard about it. I could understand that the Dutch dig 15% out of my dividend but the canadian taxman take tax from my foreign dividend in a TAX FREE saving account is out of my comprension.

I think you misunderstand. Foreign withholding taxes are taken off by the source country, not by the Canadian Government. That’s why they are called “withholding” taxes. The Canadian Govt. gives you the foreign tax credit so you can claim it back.

You only have to claim the capital gains then if you sell the shares.. Most countries impose withholding taxes on foreign income.

Most countries also have limitations on foreign holdings in registered accounts. There’s no rip-off, you just have to understand how to optimize your holdings in the right accounts.

Currently most Canadian (everything) is really sucking rocks(for want of a better word). Would I not be better off buying American stocks/ETFs that are currently posting really good capital gains that “happen” to also be paying a decent dividend within my TFSA as my RRSP is maxed but my TFSA is not even though I suffer a non recoverable 15% witholding tax on the dividend portion? About the best dividend payer on the Canadian market is Penn West Petroleum however this is a stock I won’t own as I do not think their dividend payout is sustainable with a P/E over 27.5 perhaps in future if the recent bump in ng prices hold but not currently.
This is my possibly flawed reasoning until the tsx stops being so sluggish then perhaps at a future date rebalance more into canadian equities. My other reason is to take advantage of the near par value of the Canadian dollar while it still remains strong.
Call me a pessimist but it is looking more and more like it is going to take a wee tumble.

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